A mostly macro- and international economics weblog for students (and anyone else!)

Tuesday, September 1, 2009

Hysteresis and the WTO

The US won its WTO dispute over auto parts with China, the Times reports, but the victory may be meaningless, in practice:

After four years of negotiations and W.T.O. reviews, the Chinese government announced late Friday that it would comply with the organization’s ruling that China must reduce its steep tax on imported auto parts for cars that do not meet certain local standards.

But the delay in changing its trade policies served to limit imports. During the lengthy negotiations, foreign automakers moved production to China on a large scale. The automakers with assembly plants in China have largely stopped using imported auto parts, partly to avoid paying the steep taxes on these parts and partly because international auto parts manufacturers moved production to China.

Because there are fixed costs and comparative advantage is not static, the time involved in resolving disputes at the WTO matters. Since the case would almost certainly take a long time and the outcome was uncertain, it was worthwhile for manufacturers to pay the fixed cost of setting up in China. China was, in effect, able to protect an "infant industry," and induce investment in auto parts manufacturing (i.e., in terms of neoclassical trade theory, change its factor "endowment"). Therefore, by the time China "lost" the case, it had a globally competitive auto parts industry.

Such "path dependence" is sometimes referred to as "hysteresis" after the property of metals that retain a magnetic effect after coming into contact with a magnet.

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